Mercatus Center : Financial Marketshttps://www.mercatus.org/taxonomy/term/726/feed
enResponse to Bureau of Consumer Financial Protection Request for Information Relating to Bureau Supervision Processeshttps://www.mercatus.org/publications/response-bureau-consumer-financial-protection-request-information-relating-bureau
<p>We appreciate the opportunity to respond to the Bureau of Consumer Financial Protection’s (Bureau) request for information on its supervision activities. The Mercatus Center at George Mason University is dedicated to bridging the gap between academic ideas and real-world problems and to advancing knowledge about the effects of regulation on society. This comment, therefore, does not represent the views of any particular affected party or special interest group but is designed to assist the Bureau as it considers whether it should modify its enforcement activities. Specifically, we wish to address how to ensure that the Bureau supports financial innovation that can benefit consumers by supporting regulatory sandboxes and using regulatory contracting to provide regulatory certainty to market participants. More generally, this comment seeks to assist the Bureau in embracing a regulatory approach that benefits consumers by allowing for competition and innovation while providing necessary consumer protections.</p>
<p>Innovation can be a powerful tool in helping provide consumers with better financial services and a more competitive financial services market. A regulatory environment that provides a space for firms to experiment while still providing appropriate consumer protection, and provides market participants with regulatory certainty, will help to encourage this positive innovation. One tool that regulators can use to further this goal is a “regulatory sandbox,” which has been used by foreign regulators and is beginning to be adopted in the United States, with the state of Arizona being the first government to do so. Another related tool would be to implement new regulatory contracts to help give regulated entities clarity and confidence as to their regulatory obligations. The Bureau could use these two tools independently but could also use them together to powerful effect.</p>
<h3>The Potential for a Regulatory Sandbox</h3>
<p>One supervision tool the Bureau has expressed interest in, either on its own accord or with an eye toward facilitating state regulators’ use of it, is the “regulatory sandbox.”</p>
<h4>What Is a Regulatory Sandbox?</h4>
<p>A regulatory sandbox is a fairly recent development in financial regulation. The United Kingdom’s Financial Conduct Authority (FCA) is generally regarded as implementing the first sandbox in 2015, with numerous countries following suit or announcing their plans to do so.</p>
<p>While regulatory sandboxes vary in their constitution, their general purpose is to provide an environment where companies can try a new product or service on a small number of customers to determine if the product or service works with limited regulatory exposure while ensuring that the customers testing the service are protected. In exchange for participating in the sandbox, companies frequently agree to provide the regulator with data and allow continuing oversight.</p>
<p>Firms seeking to use a regulatory sandbox are highly unlikely to be bad actors seeking to take advantage of consumers. Instead, these are firms looking to engage with regulators and experiment with new products for which there is some regulatory uncertainty. While sandboxes should require that the companies compensate customers harmed by the product or service being tested if the harm is caused by a violation of consumer protection law, fines and penalties meant to punish or deter bad acts are not appropriate.</p>
<p>In some cases, like that of the FCA sandbox, a major form of regulatory relief is a relaxation of the licensing requirements for a financial services firm. A company that would need a license to offer a service can test the service in the sandbox without getting the full license, and if the service works the company can proceed to obtain the license. Other powers provided by a sandbox can include the waiver or modification of rules, informal guidance, and no-action relief.</p>
<p>While federal regulators, including the Bureau, utilize some of these tools already, there is no formal regulatory sandbox at the federal level. However, there is movement among the states to create sandboxes. Arizona is the first US state to establish a regulatory sandbox, and other states are expected to follow suit.</p>
<h4>The Role of the Bureau in Supporting the States</h4>
<p>Advances in technology have the potential to improve the quality of financial services, but innovations may also pose risks or generate uncertainty for regulators. States are well suited to experiment with different regulatory methods of encouraging innovation on a small scale, allowing for experimentation and education that can be shared while limiting the scope of mistakes. Therefore, it is in the best interests of consumers that the states be able to function as true “laboratories of democracy” and be able to conduct meaningful experiments with financial services. The Bureau, as the primary federal consumer protection regulator for financial services, is uniquely positioned to help or hinder the use of state regulatory sandboxes. The Bureau should take steps to avoid discouraging the use of state sandboxes or of frustrating the purpose of state sandboxes, and it should assist states where appropriate.</p>
<p>One risk facing state sandboxes is the possibility of inconsistent overlapping federal regulation. Even if a firm and its customers are based in the same state, the Bureau and other federal regulators likely retain jurisdiction. Firms considering whether to enter a state sandbox therefore need to worry that any regulatory relief or forbearance they receive from state regulators will be negated by the federal government. Not only would this deprive the firm of the benefits of a state sandbox, but it would also deprive the state and consumers of the benefits of innovation provided by the sandbox.</p>Mon, 21 May 2018 12:07:26 -0400J. W. Verret, Brian Knighthttps://www.mercatus.org/publications/response-bureau-consumer-financial-protection-request-information-relating-bureauRethinking Decimalizationhttps://www.mercatus.org/publications/decimalization-increased-tick-sizes-trading-activity-volatility
<p>In October 2016, the Securities and Exchange Commission (SEC) launched a pilot program designed to increase trade in small stocks. The program raised the minimum trading increments, or “tick sizes,” for 1,400 small-capitalization stocks. Its objective was to determine whether increasing tick sizes from $0.01 to $0.05 would improve the liquidity and overall market quality of stocks that were part of the program.</p>
<p>In short, would the increase in tick sizes from $0.01 to $0.05 improve trading in these stocks? Would it entice more market makers to participate and, thus, improve capital access for smaller companies?</p>
<p>Benjamin M. Blau and Ryan J. Whitby set out to answer those questions in “Rethinking Decimalization: The Impact of Increased Tick Sizes on Trading Activity and Volatility.” After examining a preliminary report of the SEC’s pilot program, they conclude that the answer is “no.” If anything, the program seems to harm the market quality of the affected stocks.</p>
<p>The SEC pilot program marked the first change in tick sizes since 2001. That year, stock exchanges began to price shares in one-penny increments rather than in fractions of dollars. This move was generally welcomed by investors. Blau and Whitby examine the effects of the most recent experiment in tick sizes and conclude the following:</p>
<ul><li><i>Trading activity.</i> Trading volume and turnover are two traditional measures of trading activity. Neither of these measures improved for pilot stocks relative to control stocks as a result of the increase in tick sizes.</li>
<li><i>Volatility.</i> The wider minimum tick sizes were responsible for an increase in volatility for the pilot stocks vis-à-vis other stocks. This harms market quality because volatility can undermine the overall confidence of participants in the market.</li>
</ul><h3>Key Takeaways</h3>
<ul><li>The change in tick size was not effective in its underlying objective of improving market quality.</li>
<li>When the SEC’s two-year pilot program expires, it should not be extended to other nonpilot, eligible stocks.</li>
<li>A regulatory policy change is not warranted.</li>
</ul>Tue, 15 May 2018 14:10:41 -0400Benjamin M. Blau, Ryan J. Whitbyhttps://www.mercatus.org/publications/decimalization-increased-tick-sizes-trading-activity-volatilityJ. W. Verret on the Steve Gruber Radio Showhttps://www.mercatus.org/podcasts/04172018/j-w-verret-steve-gruber-radio-show
<p>J. W. Verret discusses the deregulation of Dodd Frank with host Steve Gruber.</p>
Wed, 18 Apr 2018 16:12:03 -0400J. W. Verrethttps://www.mercatus.org/podcasts/04172018/j-w-verret-steve-gruber-radio-showRegulation and Cryptocurrencieshttps://www.mercatus.org/bridge/commentary/regulation-and-cryptocurrencies
<p>Are cryptocurrencies securities, payment systems, commodities, something else, or all of the above? How should federal policymakers, and particularly federal regulators, handle emerging issues like initial coin offerings (ICOs)? A few years ago, the emergence of Bitcoin was largely a niche issue for academics and hobbyists, but its continued growth and the maturation of its underlying technology (to say nothing of other cryptocurrencies like Etherium) has made cryptocurrency a topic of intense debate in policy circles.</p>
<p>To answer those, and other questions, the Mercatus Center at George Mason University and The Institute for Financial Markets recently <a href="https://www.mercatus.org/events/smart-financial-regulation-roundtable-implications-cryptocurrencies">hosted a conference</a> in Washington, DC.</p>
<p>
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<p><a href="https://soundcloud.com/mercatus-center/smart-financial-regulation-roundtable-implications-of-cryptocurrencies">Click here</a> to listen to the event audio.</p>
<h3><strong>What are Cryptocurrencies and how are They Being Used and Regulated?</strong></h3>
<p>Paul Atkins, former Commissioner with the Securities Exchange Commission, Joseph Brady, Executive Director of the North American Securities Administrators Association, Chris Brummer, Georgetown University Law Center Professor, and Sarah Hanks, CEO of CrowdCheck, participated in a discussion moderated by J.W. Verret, Senior Affiliated Scholar with the Mercatus Center, aimed at laying out the current state of play in cryptocurrencies.</p>
<p>Former Commissioner Atkins started the conversation by providing a framework to think about when a coin or token might be considered a securities and when it makes more sense to think about it as a utility before the panel covered different uses for cryptocurrency coins and the challenges potential users face given regulatory uncertainties. That problem can be magnified, according to Hanks, by potential businesses expressing eagerness to use blockchain technology without having fully thought through what they actually want to use to technology to do.</p>
<p>Much of the remaining conversation centered around the “Howey test.” Coined following the Supreme Court case SEC v. W.J. Howey, the test was created by the Court in order to clearly identify what financial contracts should count as “investments.”</p>
<p>Professor Brummer also noted the “trilemma of innovation,” arguing that when trying to create clear rules, achieve market integrity, and foster financial innovation, policymakers can usually only manage two out of the three.</p>
<p>Executive Director Brady discussed enforcement issues, emphasizing that NASAA is concerned about “significant fraud” in the cryptocurrency and ICO space. Brady highlighted Texas in particular, and their use of social media to identify and pursue fraud investigations.</p>
<h3><strong>The Regulatory Response to Cryptocurrencies</strong></h3>
<p>Gary DeWaal, Special Counsel with Katten Muchin Rosenmann LLP, moderated the second panel featuring Jerry Brito, Executive Director of Coin Center, Ryne Miller, Associate with Sullivan &amp; Cromwell, Brian Trackman, Fintech and Innovation Counsel with the Commodity Futures Trading Commission (CFTC), and Angela Walch, Associate Professor at St. Mary’s University School of Law.</p>
<p>Beginning the conversation, DeWaal broke down the basics of cryptocurrencies, likening the underlying technology to email, Excel, and the buying and trading of stocks before turning to the panel. Brito added the importance of Bitcoin’s peer-to-peer connection, eliminating the need for a third party intermediary, and the value of creating verifiable transactions by overcoming the lack of inherent scarcity for digital goods.</p>
<p>Miller pointed to the SEC’s no-action letters stating that baseball teams selling the right to purchase season tickets (not the tickets themselves) were not engaged in securities trading. He noted that while this precedent hasn’t necessarily been a focal point for recent regulatory conversations regarding cryptocurrencies, it may in the future.</p>
<p>Walch called for regulatory clarity and predictability, citing regulators’ efforts to “take action at the right time,” in order to protect consumers and avoid stifling innovation. She pointed to the initiative state policymakers are taking as evidence that the time for regulatory clarity has arrived. Walch also noted that many assumptions, including those made by policymakers, about cryptocurrencies might be wrong. Specifically, she pointed out that concentration in cryptocurrency “mining” makes some public blockchain systems less decentralized and more susceptible to collusion than is commonly believed.</p>
<p>Trackman observed his lack of surprise that different regulators were exploring their role in cryptocurrency policymaking. He argued that the cryptocurrency market is still new, and cited Pets.com as an example from the early days of the internet, when companies who seemed to dominate the landscape one year could disappear the next.</p>
<h3><strong>Fireside Chat with CFTC Commissioner Rostin Behnam</strong></h3>
<p>Brian Knight, Director of the Mercatus Center’s Program on Financial Regulation, sat down with CFTC Commissioner Behnam to discuss the Commission’s approach to cryptocurrency.</p>Mon, 16 Apr 2018 17:43:06 -0400Chad Reesehttps://www.mercatus.org/bridge/commentary/regulation-and-cryptocurrenciesSmart Financial Regulation Roundtable: Implications of Cryptocurrencieshttps://www.mercatus.org/podcasts/04162018/smart-financial-regulation-roundtable-implications-cryptocurrencies
<p>The Institute for Financial Markets and the Mercatus Center at George Mason University co-hosted an educational event on the financial regulation of cryptocurrencies. This timely conversation discusses the regulation of crypto-assets within the securities and futures markets.</p>
<p>Leading experts discuss the current state of play in cryptocurrencies. How are they being used and what problems can they potentially solve? How are cryptocurrencies currently regulated and does that regulation make sense? Hear from scholars, regulators, and industry experts as they debate whether digital assets pose unique risks and how regulators should adapt to the new technology.</p>
<p>This meaningful study discusses what structural, procedural, or substantive regulatory changes might need to be addressed and what policymakers and regulators might do to help cryptocurrencies achieve their potential while minimizing risk.</p>
<p><strong>Opening Remarks</strong></p>
<ul><li>Trish Foshée, President, The Institute for Financial Markets</li>
<li>Brian Knight, Director of the Program on Financial Regulation and Senior Research Fellow, Mercatus Center at George Mason University</li>
</ul><p><strong>Panel I: The State of Play in Cryptocurrencies What are cryptocurrencies and how are they being used and regulated?</strong></p>
<ul><li>Paul Atkins, Chief Executive Officer, Patomak Global Partners, LLC</li>
<li>Joseph Brady, Executive Director, North American Securities Administrators Association</li>
<li>Chris Brummer, Professor, Georgetown University Law Center Sara Hanks, CEO, CrowdCheck</li>
<li>Moderated by J.W. Verret, Senior Affiliated Scholar, Mercatus Center at George Mason University</li>
</ul><p><strong>Panel II: The Regulatory Response to Cryptocurrencies What should regulators and policymakers do to help cryptocurrencies achieve their potential while minimizing risk?</strong></p>
<ul><li>Jerry Brito, Executive Director, Coin Center</li>
<li>Ryne Miller, Associate, Sullivan &amp; Cromwell, LLP</li>
<li>Brian Trackman, Counsel on FinTech and Innovation, ‎Commodity Futures Trading Commission</li>
<li>Angela Walch, Associate Professor, St. Mary's University School of Law</li>
<li>Moderated by Gary DeWaal, Special Counsel, Katten Muchin Rosenman LLP</li>
</ul><p><strong>Fireside Chat:</strong> Rostin Behnam, Commissioner, Commodity Futures Trading Commission</p>
Mon, 16 Apr 2018 17:49:57 -0400Brian Knight, Jerry Britohttps://www.mercatus.org/podcasts/04162018/smart-financial-regulation-roundtable-implications-cryptocurrenciesSmart Financial Regulation Roundtable: Implications of Cryptocurrencieshttps://www.mercatus.org/videos/smart-financial-regulation-roundtable-implications-cryptocurrencies
<p>The Institute for Financial Markets and the Mercatus Center at George Mason University co-hosted an educational event on the financial regulation of cryptocurrencies. This timely conversation discusses the regulation of crypto-assets within the securities and futures markets.</p>
<p>Leading experts discuss the current state of play in cryptocurrencies. How are they being used and what problems can they potentially solve? How are cryptocurrencies currently regulated and does that regulation make sense? Hear from scholars, regulators, and industry experts as they debate whether digital assets pose unique risks and how regulators should adapt to the new technology.</p>
<p>This meaningful study discusses what structural, procedural, or substantive regulatory changes might need to be addressed and what policymakers and regulators might do to help cryptocurrencies achieve their potential while minimizing risk.</p>
<p><strong>Opening Remarks</strong></p>
<ul><li>Trish Foshée, President, The Institute for Financial Markets</li>
<li>Brian Knight, Director of the Program on Financial Regulation and Senior Research Fellow, Mercatus Center at George Mason University</li>
</ul><p><strong>Panel I: The State of Play in Cryptocurrencies </strong><br />What are cryptocurrencies and how are they being used and regulated?</p>
<ul><li>Paul Atkins, Chief Executive Officer, Patomak Global Partners, LLC</li>
<li>Joseph Brady, Executive Director, North American Securities Administrators Association</li>
<li>Chris Brummer, Professor, Georgetown University Law Center Sara Hanks, CEO, CrowdCheck</li>
<li>Moderated by J.W. Verret, Senior Affiliated Scholar, Mercatus Center at George Mason University</li>
</ul><p><strong>Panel II: The Regulatory Response to Cryptocurrencies</strong><br />What should regulators and policymakers do to help cryptocurrencies achieve their potential while minimizing risk?</p>
<ul><li>Jerry Brito, Executive Director, Coin Center</li>
<li>Ryne Miller, Associate, Sullivan &amp; Cromwell, LLP</li>
<li>Brian Trackman, Counsel on FinTech and Innovation, ‎Commodity Futures Trading Commission</li>
<li>Angela Walch, Associate Professor, St. Mary's University School of Law</li>
<li>Moderated by Gary DeWaal, Special Counsel, Katten Muchin Rosenman LLP</li>
</ul><p><strong>Fireside Chat:</strong> Rostin Behnam, Commissioner, Commodity Futures Trading Commission</p>
Mon, 16 Apr 2018 17:56:09 -0400Brian Knight, Jerry Britohttps://www.mercatus.org/videos/smart-financial-regulation-roundtable-implications-cryptocurrenciesYes, the Benefits of a Higher Leverage Ratio Can Exceed the Costshttps://www.mercatus.org/publications/bank-regulatory-capital-standards-benefits-costs
<p>After the 2007–2008 financial crisis, some academics and lawmakers from both parties have proposed simpler, higher bank capital requirements as a way to strengthen banks and prevent future disasters. For instance, Professors Anat Admati and Martin Hellwig suggest raising the so-called equity-to-asset ratio, or “leverage” ratio, for banks to 20 or 30 percent, while Senators Sherrod Brown and David Vitter cosponsored a bill calling for a ratio of 15 percent. Under such proposals, banks would finance their activities with more equity and less debt.</p>
<p>Two questions arise: How much would a higher bank leverage ratio actually cost? And what benefits would result? We answer these questions in our recent Mercatus Center working paper, which is summarized here.</p>
<p>One plausible answer to the first question, suggested by Franco Modigliani and Merton Miller’s famous theorem, is that raising the leverage ratio has no associated costs. Intuitively, under certain conditions, a bank with a higher leverage ratio would pay a lower return on equity than its more leveraged competitors since the risk of default would be lower. The reduced return on equity, therefore, could fully offset the increased cost of relying more on equity, which pays a relatively higher return than debt.</p>
<p>Critics of the Modigliani-Miller theorem claim that it does not hold and that a higher leverage ratio <i>would</i> raise a bank’s overall cost of funds. The bank would then pass along higher funding costs to borrowers, and the end result would be less borrowing, less capital formation, and a lower GDP. If the critics are right, a higher leverage ratio would be acceptable only if the benefits exceed the costs. Thus, before attempting to reduce the likelihood of a banking crisis, we must justify the approach. We must show that, in decreasing the adverse effect such crises have on GDP, the benefits will exceed any costs that might arise from lower capital formation and lower GDP. We turn to that task now.</p>
<h3>Costs of a Higher Leverage Ratio</h3>
<p>To illustrate how a higher leverage ratio could have costs that translate into forgone GDP, consider the example summarized in table 1. In the first quarter of 2008, total assets for US banks in our sample equaled about $10 trillion. An 11 percentage point increase—equal to the increase in the leverage ratio from 4 percent to 15 percent that we consider in the paper—would require the banks to raise an additional $1.1 trillion in equity while retiring $1.1 trillion in debt.<img class="media-element file-mercatus-full-page mercatus-embed mercatus-embed-image" data-delta="2" data-media-url="https://www.mercatus.org/sites/default/files/screen_shot_2018-04-05_at_8.52.10_am.png" src="https://www.mercatus.org/sites/default/files/screen_shot_2018-04-05_at_8.52.10_am.png" width="1610" height="712" alt="" /></p>
<p>In our highest-cost case, assuming the return on equity equals 12 percent, banks would have to pay an additional $132 billion to shareholders if the leverage ratio rises by 11 percentage points. The increased payments to shareholders would be partially offset by lower interest expenses from retiring the debt. Assuming a 5 percent rate of interest, the reduced debt costs would amount to $55 billion for an 11 percentage point increase in the leverage ratio.</p>
<p>On net, banks with total assets equaling $10 trillion would face additional costs of capital of $77 billion for an 11 percentage point increase. Looked at another way, for an 11 percentage point higher leverage ratio, the costs would rise by 99 basis points. Banks might try to recover these costs by charging higher interest rates on their loans, which could translate into less capital formation and thus forgone GDP.</p>
<p>To calculate forgone GDP, one important factor is the degree to which companies rely on banks for funding. In the United States, recent data suggest that bank lending, as a fraction of all corporate funding, averages about 7 percent. If, however, the higher costs in bank lending spill over to other debt markets, then it may be useful to consider not just bank loans but also total debt as a fraction of corporate funding. Accordingly, we use a debt-to-capital ratio of 37 percent in our baseline case and 23 percent as an alternative.</p>
<p>The results show a range of output declines. For a leverage ratio that is 11 percentage points higher, assuming a 7 percent fraction of corporate funding coming from bank loans, output declines by 4.2 percent. Assuming instead a debt-to-capital ratio of 23 percent, output declines by 13.8 percent. And assuming a debt-to-capital ratio of 37 percent, output declines by 22.2 percent.</p>
<h3>Benefits of a Higher Leverage Ratio</h3>
<p>One approach to estimating the benefits of a higher leverage ratio is to estimate the relationship between the leverage ratio and the probability of a crisis and then estimate the effects of crises on the rate of economic growth. On the first estimate, we find empirically that the probability of a banking crisis varies inversely with the leverage ratio, so that a higher leverage ratio produces benefits in the form of lower crisis costs.</p>
<p>On the second estimate, the Bank of England’s 2010 <i>Financial Stability Report</i> and Miles, Yang, and Marcheggiano assume that the cost of a crisis equals a 10 percent decline in GDP and that 75 percent of the effects of a crisis are temporary, lasting five years. For the United States, in our baseline case we assume 90 percent of crisis effects are temporary and last two years. We also estimate that for the United States the cost of a crisis equals a 10.3 percent decline in GDP. Additionally, we examine the impact of assuming crises’ effects are either 75 percent temporary or 100 percent temporary. The expected benefit of higher capital requirements per percentage point reduction in the probability of a crisis equals</p>Thu, 05 Apr 2018 08:59:14 -0400James R. Barth, Stephen Matteo Millerhttps://www.mercatus.org/publications/bank-regulatory-capital-standards-benefits-costsWhat We’re Reading: Toys R Us Bankruptcy, Other Galaxies, and the FDIChttps://www.mercatus.org/bridge/commentary/whatreading3-30-18
<p>Here’s a quick round-up of some of the links shared by Mercatus Center scholars this week:</p>
<ul><li>Michael Farren <a href="https://twitter.com/MichaelDFarren/status/976316480022249472">shared</a> “a great story of how people can achieve environmental conservation without relying on the government,” and <a href="https://twitter.com/MichaelDFarren/status/976248210359554049">a video</a> from <em>MSN</em> on a Toys R US claim that childless millennials led to their bankruptcy.</li>
<li>James Broughel <a href="https://twitter.com/JamesBroughel/status/979554384047636480">t</a><a href="http://twitter.com/JamesBroughel/status/979554384047636480">weeted</a> about Yale researchers who discovered a galaxy without dark matter.</li>
<li>Matthew Mitchell <a href="https://twitter.com/MattMitchell80/status/979392990471905280">shared a paper</a> by Joshua C. Hall, Donald J. Lacombe, and Timothy M. Shaughnessy comparing economic freedom with income levels across US states.</li>
<li>Christine McDaniel <a href="https://twitter.com/christinemcdan/status/978386799348342784">tweeted</a> an article by Joy Dantong Ma on “Steel Tariffs’ Chilling Effect on American Manufacturing.”</li>
<li>Emily Hamilton <a href="https://twitter.com/EricFidler/status/979026605463961600">retweeted</a> Eric Fidler’s highlighting of a <em>WAMU</em> story on density in northwest DC.</li>
<li>Brian Knight <a href="https://twitter.com/WSJFinReg/status/978755754638434304">shared</a> a <em>Wall Street Journal</em> article on the pending Senate confirmation of Jelena McWilliams, nominee to head the Federal Deposit Insurance Corporation.</li>
</ul>Fri, 30 Mar 2018 10:09:46 -0400Chad Reesehttps://www.mercatus.org/bridge/commentary/whatreading3-30-18Regulatory Contracts Needed to Hold Consumer Financial Bureau Accountablehttps://www.mercatus.org/commentary/regulatory-contracts-needed-hold-consumer-financial-bureau-accountable
<p>New leadership at the Consumer Financial Protection Bureau promises a whole new approach to running the agency. A new director will have the opportunity to swiftly implement a law-based approach to rule-making through rescinding guidance, changing enforcement priorities, and placing more rules through a more transparent notice and comment process. New leadership will be able to accomplish this objective in part because of the unprecedented independence and authority Congress placed in that agency.</p>
<p>But what’s to stop the next CFPB director from falling into politically motivated abuses of discretion? The same discretion afforded to the agency could once again be used to swing the agency’s priorities away from a rule of law approach, and away from clear guidance to help foster innovation in consumer finance. One tool the CFPB could use to cement interpretations of rules is the regulatory contract.</p>
<p>Consider the case of U.S. v. Winstar Corp. During the aftermath of the Savings &amp; Loan (S&amp;L) crisis, the Office of Thrift Supervision encouraged healthy thrifts to buy up distressed thrifts, and along the way they made promises to healthy thrifts in binding contracts about which accounting methods they could use in determining regulatory capital requirements.</p>
<p>Congress later changed the law, but the Supreme Court upheld the binding commitment by the Office of Thrift Supervision and awarded damages to the thrifts that relied on the promises of their regulator. This was a particularly strong case because Congress changed the law! The Supreme Court found in Winstar that the regulatory agency assumed the risk of subsequent legal change as an agent of the government in the contract.</p>
<p>The Supreme Court explicitly recognized the legitimacy of agency’s entering into binding contracts to accomplish regulatory objectives. Subsequent cases interpreting Winstar have been unwilling to second guess the elements of the contract, like offer, acceptance, or consideration, and instead err in favor of holding government agencies to their regulatory contracts.</p>
<p>The government is held to a high standard in regulatory contracts, and even when underlying promises are found to involve technical violations of law, the regulated party often wins anyway. The court reasons that the government is in a better position to interpret the law than the regulated party, and the government is held to a high standard of good faith dealing.</p>
<p>One way in which regulatory contracts could prove particularly useful at the CFPB is in creating a healthy “regulatory sandbox” for new innovators in consumer finance. The CFPB previously introduced “Project Catalyst” to encourage innovators to come to the CFPB and get assurance about how laws would not unintentionally impede new innovations in finance that were not anticipated in prior regulations. Similar regulatory sandbox approaches have proved successful in the United Kingdom. And yet Project Catalyst has catalyzed very little; industry participants report their fear that the CFPB might later reverse course and use information obtained through Project Catalyst against them in an enforcement action.</p>
<p>That problem will remain under the new administration. Regulatory contracts could provide the assurance and predictability that Project Catalyst was intended to introduce.</p>
<p>This is certainly not an optimal approach to governance. Ideally agencies would put clear rules through a transparent notice and comment process. They should conduct objective cost-benefit analysis of those rules to ensure new rules do not diminish consumer access to credit. They shouldn’t bring enforcement actions based on erroneous interpretations of law. The CFPB has been subject to critiques for failure to meet all of those standards from both Republicans and Democrats since. Under future leadership it may commit the same infractions.</p>
<p>The CFPB could adopt a number of policies to ensure transparency in the regulatory contracting process. For example, the agency could put its process for reviewing regulatory contracts through a public notice and comment process. It could further put individual regulatory contracts through notice and comment. It could publicize the standard language it intends to include in regulatory contracts.</p>
<p>Companies that provide funding to main street businesses and are eager to follow the law, but to do that, they need to know what the law requires. Regulatory contracts are a useful and legitimate tool to bind the CFPB to its commitments to regulated entities. They have been successfully used by banking regulators in the past and should be considered as a helpful tool in the CFPB’s regulatory toolbox going forward.</p>
Tue, 03 Apr 2018 11:51:54 -0400J. W. Verrethttps://www.mercatus.org/commentary/regulatory-contracts-needed-hold-consumer-financial-bureau-accountableHow the CFPB and Other Federal Regulators Can Help State Sandboxes without Messing Them Uphttps://www.mercatus.org/bridge/commentary/how-cfpb-and-other-federal-regulators-can-help-state-sandboxes-without-messing
<p>I have <a href="https://finregrag.com/how-the-cfpb-could-help-state-regulatory-sandboxes-d299c2e95ca5">previously written</a> about how the Consumer Financial Protection Bureau (CFPB) could help state regulatory sandboxes by exempting the conduct of firms operating in, and consistent with the requirements of state regulatory sandboxes from Title X of Dodd-Frank. This assistance is largely defensive in nature, in that it removes regulatory risk from firms. However, with the <a href="https://www.bna.com/arizona-becomes-first-n57982090236/">passage</a> of Arizona’s <a href="https://apps.azleg.gov/BillStatus/GetDocumentPdf/459033">regulatory sandbox</a> (the first in the country!) it might be worth thinking about how the CFPB (and other federal regulators) could provide positive assistance to the states in a way that doesn’t undo the benefits of the sandbox. I’ll focus on the CFPB here, but similar issues may exist for other relevant federal regulators.</p>
<p>One major way that the CFPB could potentially help is by lending its expertise to assist state regulators in assessing data. This isn’t to imply that states necessarily lack expertise on any given issue, but the CFPB has a lot of economists on staff who should be both able to help the states where needed and interested in the results of the sandbox. Assisting the states without stepping on their toes would help improve the markets for consumer services, and be consistent with <a href="https://www.americanbanker.com/news/ags-not-cfpb-should-take-greater-role-on-enforcement-mulvaney">the vision</a> Acting Director Mick Mulvaney laid out when calling on state attorneys general to serve as primary enforcers with the CFPB providing assistance.</p>
<p>Of course, one of the potential problems with the CFPB helping is that it risks damaging the trust between companies and state regulators. The sandbox relies on trust, and while a company may be able to trust its state regulator to abide by the terms and limitations of the state sandbox, the CFPB and other federal regulators are not bound by those rules. This means that while the company may feel comfortable with the potential risk they take on at the state level by participating in a sandbox, the federal risk is unknown.</p>
<p> But is that a bad thing? Do we want companies to avoid risk for violating regulations? It is important to take a moment to clarify something: the firms we are talking about are not bad actors trying to defraud customers, but firms trying new means of serving customers needs in collaboration with state regulators who, in turn, are incentivized to care about consumer protection because the consumers in question are citizens of the state. Discouraging this experimentation is not in the best interests of the consumer.</p>
<p>This is why, if we want state sandboxes to be maximally effective, the CFPB needs to be credibly limited in how it uses the data it obtains if and when it participates in state sandboxes. The ability of the CFPB to exempt certain firms mentioned above could help, but as <a href="https://finregrag.com/could-the-cfpb-create-its-own-regulatory-sandbox-888b19077f44">previously acknowledged</a>, even that exemption only goes so far. While the CFPB can exempt a firm from Title X of Dodd-Frank, it can’t exempt a firm from other federal consumer protection laws, leaving the door open for other federal regulators to intercede.</p>
<p>Congress stepping in to address this would be ideal, but it seems unlikely that Congress will act quickly. Still, the regulators themselves could address at least some of these risks. Regulators could resolve uncertainty via memoranda of understanding between regulators clarifying that they will generally defer to the states.</p>
<p>However, that still leaves the firms seeking some additional level of certainty. My colleague J.W. Verret <a href="http://thehill.com/opinion/finance/380528-regulatory-contracts-needed-to-hold-consumer-financial-bureau-accountable">has argued</a> the answer may lie in regulatory contracts. Under one of these contracts the firm and the regulator would agree to take or refrain from certain acts, such as the regulators using data obtained in the sandbox for an enforcement action outside the sandbox’s terms. If the regulator breaks their promise, the regulated entity can get monetary damages or even an injunction. These agreements could limit regulatory risk for firms entering state regulatory sandboxes, encouraging their use.</p>
<p>The rise of state regulatory sandboxes is a potentially exciting development. The federal regulators have a role to play, both in providing expertise to help the sandbox provide the most useful information for firms, policymakers, and the public, and by showing forbearance and humility to ensure that firms and the states get the benefits of their bargain. This will require transparent, credible, and binding agreements between federal regulators, their state counterparts, and the firms using the sandbox. Hopefully they will be forthcoming. </p>
Tue, 27 Mar 2018 16:41:02 -0400Brian Knighthttps://www.mercatus.org/bridge/commentary/how-cfpb-and-other-federal-regulators-can-help-state-sandboxes-without-messing